Fed’s Warsh Quits; Bernanke Adviser Questioned QE2

Kevin Warsh, a member of the board of governors for the Federal Reserve System will resign. Photographer: Jin Lee/Bloomberg

Feb. 10 (Bloomberg) -- Federal Reserve Governor Kevin
Warsh, who was one of Chairman Ben S. Bernanke’s closest
financial-crisis advisers before becoming the only governor to
question the expansion of record monetary stimulus in November,
resigned after five years at the central bank.

Warsh, 40, a former investment banker who was the youngest-ever Fed governor when then-President George W. Bush appointed
him in 2006, will leave “on or around March 31,” he said in a
letter today to President Barack Obama that was released by the
Fed in Washington.

His departure may give Bernanke a stronger hand to complete
or potentially expand $600 billion in Treasury purchases through
June. At the same time, Bernanke loses a link to Wall Street
executives and Republican politicians as he carries out
Congress’s overhaul of financial regulation and faces criticism
from a political party that in the midterm election gained
control of the U.S. House.

“You lose a forceful internal advocate for ending QE and
trying to renormalize policy quicker,” said Vincent Reinhart,
the Fed’s director of monetary affairs from 2001 to 2007,
referring to the stimulus program known as quantitative easing.

The move also “deepens the void” in financial-markets
expertise at the Board of Governors after former Vice Chairman
Donald Kohn, a 40-year central bank veteran, left in September,
said Reinhart, a scholar at the American Enterprise Institute in
Washington. That may leave Bernanke more dependent for market
insight on New York Fed officials including William Dudley,
president of the regional bank, Reinhart said.

Five-Year Term

Separately, Dudley will probably be reappointed to a five-year term starting March 1, a person familiar with the matter
said today. He was named New York Fed chief in January 2009 to
finish the term of Timothy F. Geithner, who became Treasury
Secretary. The board of the regional bank appoints presidents to
five-year terms, subject to approval by the Board of Governors
in Washington.

Warsh’s term would have run through January 2018; most Fed
governors don’t serve out their full terms. His resignation
opens a second vacancy on the seven-member Board of Governors
and leaves Elizabeth Duke, a former community banker, as the
only governor not appointed or reappointed by Obama.

Duke’s term expires in January 2012, and she can stay after
that until a replacement is appointed. Obama’s nomination of
Peter Diamond, a Nobel Prize-winning economist from the
Massachusetts Institute of Technology, is pending in the Senate
again after failing last year.

Second Vice Chairman

The White House also must designate a Fed governor to be a
second vice chairman in charge of supervision, as required by
last year’s Dodd-Frank Act overhauling financial regulation. It
has two other regulatory vacancies in the chiefs of the Office
of the Comptroller of the Currency and the agency overseeing
Fannie Mae and Freddie Mac.

“I am honored to have served at a time of great
consequence,” Warsh, who never dissented from a Federal Open
Market Committee decision, said in his resignation letter.
Bernanke said in a statement that Warsh’s “intimate knowledge
of financial markets and institutions proved invaluable during
the recent crisis.”

Warsh is still on good terms with Bernanke and is leaving
because he sees it as the right time with an improving economy
and not because of a policy dispute, said another person
familiar with the matter who spoke on condition of anonymity.
He’s likely to return to the private sector.

‘Greater Force’

Warsh staked out an anti-inflation stance on monetary
policy in September 2009, when he published a Wall Street
Journal op-ed and gave a speech saying the Fed may need to raise
interest rates with “greater force” than it has in the past.
In June, he said any decision to expand the $2.3 trillion
balance sheet must be subject to “strict scrutiny.”

On Nov. 8, he said in an op-ed and speech that the Fed’s
Treasury buying “poses nontrivial risks” even after he voted
to support the stimulus. He hasn’t publicly discussed his views
on the purchases since November and backed the policy at the
Fed’s subsequent meetings in December and January.

“When non-traditional tools are needed to loosen policy
and markets are functioning more or less normally -- even with
output and employment below trend -- the risk-reward ratio for
policy action is decidedly less favorable,” Warsh said in the
speech in New York. “As a result, we cannot and should not be
as aggressive as conventional policy rules -- cultivated in more
benign environments -- might judge appropriate.”

‘Soft Dissent’

John Ryding, a former Fed researcher who’s now chief
economist at RDQ Economics LLC in New York, said that day the
speech was a “soft dissent” that expressed concern about the
policy without a formal vote against it. Warsh “needs to ‘man
up’ and put his vote where his mouth is,” Stephen Stanley, an
economist who’s criticized the Fed stimulus, said in a Nov. 8
research note.

“The hurdle for dissenting for a governor is probably
somewhat higher” than for a regional Fed president, Reinhart
said. Last year, Kansas City Fed President Thomas Hoenig
dissented in favor of tighter policy at all eight FOMC meetings.

Warsh’s ambitions go back to his high school days near
Albany, New York, where he had a business buying and
distributing neon novelties, according to a 1987 article in the
Albany Times-Union.

College Freshman

As a freshman at Stanford University in California, Warsh
pestered political-science professor David Brady to attend a
senior seminar that wasn’t open to first-year students, Brady
said in 2009.

“He was so persistent,” said Brady, who became his thesis
adviser at Stanford. “He said he would get the best grade in
the class, and he did.”

After graduating from Stanford, Warsh earned a law degree
from Harvard University but never practiced, opting instead to
join Morgan Stanley in New York, where he worked in the mergers
and acquisitions department from 1995 to 2002. He then joined
the White House, advising on policies including the government-chartered home-finance companies Fannie Mae and Freddie Mac.

Warsh was an architect of the terms the Treasury dictated
to nine of the biggest U.S. banks in October 2008 in return for
a $125 billion injection of government funds. He played a
central role in negotiating the sale of the ailing Wachovia
Corp., mediating a takeover fight that erupted between Citigroup
Inc. and Wells Fargo & Co.

Intensified Crisis

Days before Lehman Brothers Holdings Inc.’s bankruptcy in
2008 intensified the crisis, a Fed staff member e-mailed Warsh
to say she hoped “we don’t have to protect” some Lehman debt
holders, according to documents released by the Financial Crisis
Inquiry Commission. Warsh replied an e-mail 30 minutes later
that “I hope we dont (sic) protect anything!”

In January 2009, Warsh was passed over for the presidency
of the New York Fed in favor of Dudley, a former Goldman Sachs
Group Inc. economist and leading advocate of the Fed’s stimulus
that’s been dubbed QE2 by investors for a second round of
quantitative easing.

Warsh has served as the Fed’s representative to the Group
of 20 and the Board of Governors’ emissary to emerging and
advanced economies in Asia. He also managed Fed operations and
personnel as the governor assigned to administration.

“He is an extraordinarily talented guy who made big
contributions to the Federal Reserve,” Atlanta Fed President
Dennis Lockhart said in an interview today. Warsh received a
standing ovation after a December speech to former Atlanta Fed
directors, Lockhart said. “I regret seeing him go.”

Warsh in 2002 married Jane Lauder, an heir to her
grandmother Estee Lauder’s cosmetics fortune, making him
wealthier than the rest of the Fed governors combined. His wife
is the global president and general manager of Estee Lauder
Cos.’ Origins and Ojon brands and is on the company’s board of
directors.